Prologis Inc (PLD) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Catellus Development Corporation 2003 Q4 earnings call. My name is Rhoda and I will be your coordinator for today. At this time, all participants are in listen-only mode and we will be facilitating a question and answer session towards the end of this conference. If at any time during the call you require assistance, please press star followed by zero and a coordinator will be happy to assist you.

I would now like to turn the call over to your host for today’s call, Ms. Minnie Wright, Director of Investor Relations. Please proceed, ma’am.

Thank you. Good morning, everyone, and thank you for standing by for the Catellus fourth quarter 2003 earnings conference call. With us today are Nelson Rising, our Chairman and CEO and Bill Hosler, our Senior Vice President and Chief Financial Officer. Both Nelson and Bill will be making a few comments regarding the highlights of our earnings release this morning. We will then open the phone lines for questions.

Before we continue, I would like to state that this conference call will contain projections and other forward-looking statements regarding future events and the future financial performance of the company. We refer you to the documents the company files from time to time with the SEC, including our Form 10-Ka for the year ended December 31st, 2002, our Form 10-Q for the third quarter of 2003, and the proxy statement prospectus dated August 15th, 2003.

These documents identify important factors that could cause actual results to differ materially from those contained in the company’s projections or forward-looking statements. Additionally, the broadcast of this call is the property of Catellus Development Corporation. Any redistribution, retransmission or rebroadcast of this call in any form, without the express written consent of Catellus is strictly prohibited.

Thank you and with all that said, I will turn the call over to our Chairman and CEO, Nelson Rising.

Good morning. Two-thousand and three was really a terrific year for Catellus and we became a REIT, effective January 1, 2004. I want to say a special word of thanks to all the team here at Catellus for the tremendous amount of work that it took to complete the REIT transaction, as well as the great year that we had.

During the fourth quarter we distributed a one-time special dividend of accumulated earnings and profits, consisting of approximately 10.6m shares of stock and approximately 100m in cash. We paid a third quarter dividend, declared a fourth quarter dividend, which we paid in January of ’04, and last week we declared a dividend for the first quarter of 2004 of $0.27, and this will be paid on April 15th.

Our EPS for 2003 was $2.30 a share, compared to $1.01 for the same period of ’02. This extraordinary year-over-year increase in net income was in large part the result of the reversal of certain deferred taxes associated with our REIT conversion. I also want to call your attention to the fact that year-over-year per share numbers are affected by the stock portion of the E&P distribution in the fourth quarter, resulting in a retroactive increase in shares outstanding in prior years.

Without the effects of the REIT conversion our EPS for 2003 would have represented a 23% increase over 2002. This strong performance was based in part, upon the increase in net operating income and a very big increase in gains on sales, which we’ll talk about in a few minutes.

Our rental portfolio continued to perform well in 2004, although NOI was down slightly in the fourth quarter of 2003, compared to the same period of 2002. NOI increased by 7.2% for the year. Our year-end occupancy of 95.2 is very gratifying to us, and I believe reflects the high quality of our portfolio. This portfolio is concentrated at major distribution centers and near major transportation quarters.

Our distribution warehouse buildings are state of the art and a majority of our portfolio has been built by Catellus since 1995, rather than being acquired from others. We think that this outstanding portfolio is the reason we’re able to maintain the very high occupancy rate.

The fourth quarter had strong leasing activity. We entered into a 62-month lease with Toto USA. This was in the existing 406,000 square foot building in Ontario Pacific Distribution Center that’s located in the Inland Empire in Southern California, a very, very strong market for us.

We also entered into a 123-month lease with a wholly owned subsidiary of The Sports Authority, Inc. And this is for 616,000 square feet and this building is located in our Kaiser’s Commercial Center in Fontana, also in Inland Empire. It’s important to also point out that we started this building on spec, but it was leased before completion.

In addition, we entered into a lease for 84,000 square feet that was started on spec, in Portland. The strong leasing activity continued into the first quarter of 2004. We extended a build-to-suit lease for an additional four years with Quaker Oats, for 451,000 square feet in Grand Prairie. That was a lease that we initially entered into in 2001. And then Quaker Oats needed an additional 292,000 square feet, which we provided them in an adjacent building.

Our development activity for the year was also very strong. We ended the year with 4.3m square feet under construction. Of this, 3.3m square feet will be added to the portfolio. One million square feet represents a development for fee. And 58,000 square feet is a build-to-suit-for-sale.

Of the 3.3m square feet to be added to the portfolio, our projected cost is 104m, and when fully leased we project a yield on cost of 10.2%. We had a 758,000 square foot distribution warehouse at Kaiser, which was started on spec, as part of that 3.3m square feet. And we now have a lease out for signature for this building. When signed, therefore, we will have 100% occupancy of the 3.3m square feet currently under construction.

No one’s saying things very positive today about Silicon Valley, where the office and industrial markets remain weak. But as you recall, we re-entitled 63 acres of our PAC Commons office site to 710,000 square feet of retail. Prior to the fourth quarter we executed ground leases with Kohl’s for 98,000 square feet and with Lowe’s for 167,000 square feet, and Costco for 157,000 square feet.

Since the fourth quarter we’ve signed build-to-suit leases for Circuit City for 34,000 square feet, and Office Depot for 16,750 square feet and we’re in active negotiations with several other tenants. So at least there’s some positive news out of the Silicon Valley.

In March of 2003, when we announced our plan to convert to a REIT, we also said that part of our transition to an industrial REIT was to monetize our non-core assets and recycle the capital generated back into our core business. I’m pleased to report that we made significant progress towards this goal in 2003. At the start of the year, the net book value of these non-core assets was $403m. During the year we monetized 140m of that, and that’s after taxes and reinvestment. We cleared 96m and still have over 400m of net book value.

Of particular interest was the sale of our 30% interest in Talega, a master plan community in San Clemente, for $47.4m, resulting in a pretax gain of $42m. Catellus and our partners acquired entitled Talega for 4,000 home sites in 1997. We had a total investment of $15.2m into the Talega partnership and we have realized $83.6m in pretax gain, which includes $42m which we received in December of 2003.

With that overview, I’ll turn the meeting over to Bill Hosler.

Thank you, Nelson. Good morning, everyone. We had very significant accounting activity in the fourth quarter as a result of the REIT conversion, so I’m going to talk about that for a little bit before we move to some of the operational issues.

As Nelson mentioned, we had quite an earnings impact this quarter on a GAAP basis, due primarily to the significant reversal of deferred taxes resulting from our REIT conversion. I know we’ve discussed this in the past, but as a REIT, we no longer expect to pay taxes on a significant portion of our deferred tax gains. Rather those gains, when realized, will be passed through to investors in the form of dividends.

Because the company is no longer a tax payer for REIT income going forward, it is no longer required to carry deferred taxes and so they have been reversed into income. We still will be liable for taxes due to income as a TRS, built-in gains audit exposure from prior returns, assets likely to contribute to the TRS with book tax differences, but those have all been accrued for.

Without the effect of the reversal, we still would have had a significant increase in EPS over last year, due to the sale of our interest in Talega to our former partners, as Nelson mentioned. As you know, we distributed over 10m shares of stock in Q4, and 100m in cash as part of our E&P distribution. Our outstanding shares now total about 102.7m shares. As a result of this distribution of shares according to GAAP, we now present all historical financial information as though those shares had been outstanding historically, similar to a stock split, although technically a stock dividend. The impact is that our 2002 EPS is now reported as $1.01, versus the $1.13 that we reported last year.

Our guidance for 2003, of $1.50 to $1.54 in core segment FFO is equivalent to $1.34 to $1.38, after the share distribution. As a result, our core segment FFO for the year is $1.35. That's flat on a per share basis, versus 2002. The other thing in the fourth quarter, we cancelled about 23m shares of treasury stock that we’ve been holding on the books from buybacks in prior years.

Also in the fourth quarter we started and completed our stock option exchange offer that was outlined in our proxy materials. As a result, we cancelled 2m option shares and granted just under 900,000 restricted stock shares that will vest over three years. Although the value is determined to be approximately equal under GAAP rules, although we were booking no charge for the options, we’re required to book a new charge for the restricted stock over its three-year vesting period. That charge will be about $20m in total over the three years. We booked about 1.7m of that in 2003 and expect to book over 6m in 2004. This charge is excluded from core segment FFO, because it relates to the REIT conversion.

We also triggered variable accounting on a small number of options not exchanged and booked, but charged for that in Q4. Again, not in our core segment. For those options not exchanged we adjusted strike prices and number of shares for the E&P distribution per Rule FIN 44, and we booked no charge as a result of those rules. All that has been laid out in the proxy previously, so there’s not really any new news there.

We continue to report our FFO for two segments. First, our core segment, which reflects that portion of our business that we anticipate will be ongoing after we fully transition the assets and operations of our company. The core segment corresponds directly to what we’ve historically provided as FFO and reflects the income property and suburban development business.

The core segment FFO for fourth quarter ’03 was $0.27, below last year’s fourth quarter of $0.32, due primarily to some severance related items and a $4.5m after-tax impairment charge related primarily to some of our core segment land holdings that we contributed to the TRS. So I want to repeat that. We had a couple of pennies in the fourth quarter in the core segment related to severance. And we had about four and a half cents related to some land impairment charges.

On our other segment, relating to our urban residential and dessert assets, we contributed about $0.48 of FFO this quarter, bringing total FFO under NAREIT to $0.75 for the quarter and $2.05 for the year. Now we’ve historically and will continue to focus primarily on the core segment, as we feel this best reflects the operations of a more typical REIT. The contribution from the urban residential other segment, while quite important and quite valuable, is very difficult to predict, will be volatile quarter to quarter and will eventually decline as those assets are sold and those businesses wound down. As that happens we will generate capital which will then be invested in the core segment, providing growth in core segment FFO.

All of the FFO numbers we’ve provided are adjusted by the hypothetical tax savings and tax impact of the conversion as though we had been a REIT in 2003. Again, nothing there is changed.

In our financial statements you’ll note that our G&A numbers are high for the year compared to prior years. About 7m of severance costs and 5m of cost related to the stock option exchange offer and other stock items that I mentioned before, so total, about $12m high. Although these costs all relate to the REIT conversion and the restructure, they’re included in G&A instead of third party REIT conversion costs. Two and a half million of these costs are actually in the core segment, relating to the severance I talked about before.

Nelson spoke about our urban residential and dessert businesses and the progress we made this past year at monetizing these assets. We started the year, if you remember, with about $400m in net book value and after all of our sale and investment activity for the year in those assets, we still have $400m in net book value. But we pulled out over $90m in capital in the form of profits in addition to that. Most of this capital is in the form of short-term notes paying a mid-single digit rate. In the supplemental on page 30, we provide more detail, kind of project by project in regard to the monetization of those assets.

Last quarter I discussed how our property operating costs were impacted by a change in how we accounted for property taxes, due to community facility district bond issuances. We started booking supplemental tax payments for these and other bonds as operating costs in the third quarter, instead of interest expense. For the fourth quarter, about $700,000 of property operating costs is merely moved from interest expense, about $1.7m for the total year.

Because we’re now accounting for infrastructure bond payments and property taxes within property operating costs, for those looking at NAV, about 60m in total infrastructure debt on the balance sheet, should be backed out of NAV, as the debt cost is already accounted for in the property NOI. And I can explain more of this later if anyone wants more detail on that.

Now finally, on the operating side, our occupancy rate is strong, as Nelson said, 95.2%. In the industrial portfolio we have only three markets where the occupancy is under 95%. Those are Northern California, Ohio and Texas. The one sizable space we have in Texas, almost 300,000 feet, that was available at the end of the year, has since had a lease signed. Nelson mentioned that, the Quaker Oats deal. However, we will likely have some vacancy in Texas soon, we have some rollover here in the next year or two.

Our biggest market, Southern California, remains strong, 97.6% occupied, no vacancy in the Inland Empire. A quarter of our overall vacant portfolio today is in the retail and office assets. The weakest performance we have by far, is in the office sector, is in our San Jose buildings and in Chicago. Retail’s fine overall. One particular center in Arizona accounting for most of the vacancy and that’s an anchor tenant we had go down last year.

The same storefront we were down significantly in the quarter at 5.5% over fourth quarter of last year on a GAAP basis, down 2.3% on a full year basis. The primary reason for the quarter-over-quarter decline in the fourth quarter was we had some extraordinarily high repair and maintenance expenses in the fourth quarter that were really brought in from next year. We spent money in the fourth quarter, in particular compared to the fourth quarter of ’02. The timing of some of our annual CAM reconciliations, we try to do a true-up in the fourth quarter and that resulted in some charges that did hit. And this accounting change was due to the bond expense that I discussed. And then of course, we did have slightly lower rents in occupancy in the same store.

Year-to-date, same store NOI declined due to the increase in R&M projects, higher insurance expense, and the tax category due to the inclusion of bonds as operating expense as I talked about.

Overall occupancy was higher in 2003. Revenue actually only declined about 0.1%. The majority of our same store change was due to expenses. We have about 4m square feet rolling over in 2004, 3.6m of this is industrial. Our loss to lease on industrial is expected to be about 7%, primarily in Northern California and Chicago, which accounts for about half of our industrial expirations. Our expectation for 2004 is to maintain occupancy, but given that some of our rollovers are slightly ahead of market today, we would expect a slight decline in same store.

The two office properties in San Jose and downtown Chicago, continue to show weakness in same store. We probably have 25 to 30% loss to lease on the rollovers that we have this year. And that’s about 120,000 feet in those two properties. Now in Southern California we have about 136,000 feet of office rolling. We’ll probably have a gain in market rents over existing rents of about 8%. But overall, we’d expect office to continue to show difficulty in this next year, because of these two particular projects.

Based on our current projections, most newly vacant space that will result this year from our rollover, we’ve made up by leasing existing space. We expect our occupancy to continue in the 94 to 95% percent range. This leads me to guidance.

We have posted on our website a summarized income statement with our guidance for 2004. Although we have provided a point estimate of $1.42, the numbers estimated end up somewhere in a range around that number. For 2004 in the core segment, we see NOI growing slightly to 227m, including our hotel JV income. And that increase is predominantly, in fact, is all through development, as the same store, as I mentioned, will be under a little bit of pressure.

Core segment sales and development fees will in total stay about the same in 2004 as 2003. G&A should go down, because of some of the one-time items we talked about and also some of the ongoing cost savings we have going here. Interest should go up due to some planned financing and lower projected capitalization of interest. But that particular category is going to have probably the most variability in my numbers and it just depends on timing issues of building starts and project sales.

We will pay some taxes in the core segment due to the development sales and fees. And we’re estimating that to be about $3m. I do want to point out one last thing, in the first quarter here, we have closed or expect to soon close a couple of small build-to-suit transactions, some land deals and a larger JV that will all run through the core segment, making our first quarter much higher than our next three quarters.

In the urban residential other segment, sales here are difficult to predict, but we’ve made an estimate in our guidance. Those numbers will clearly have a lot of variability during the year.

And at this point I’ll open it up for questions.

Ladies and gentlemen, if you wish to ask a question, please press star followed by one on your touch-tone telephone. If your question has been answered or you wish to withdraw that question, press star followed by two. Questions will be taken in the order received. Again, that’s star one to begin. And your first question comes from David Copp, from RBC Capital. Go ahead, sir.

Hi. Good morning, guys. I’m here with Jay as well. Could you just speak briefly about your view on speculative development at this point? It looks like you’re fairly close to having 100% pre-leased pipeline here. And given that you’re kind of up to your eyeballs in liquidity next year and the consensus seems to be that the markets are rebounding, what’s your view on some near-term speculative development starts?

Well, I think the response would be, it depends on which market. We really are very, very high on the Inland Empire market and Los Angeles market in Southern California. And I don’t think there’s any doubt that we would be favorably inclined to doing some spec with the development there. We’ve successfully had, with the three transactions I mentioned in my earlier comments, has demonstrated that the buildings weren’t spec’ed for very long.

Other markets, I think we like where Denver is and I think there’s a strong possibility of doing a spec there. Atlanta is a very challenging market with about 14% vacant, but I think there are some very good pockets of opportunity. And we would look at possibly doing something there.

We’re very, very high on the Northern New Jersey market, with the [positive] property we purchased in [indecipherable] at [Exit] 12-A and we would probably do a spec – we actually are going to do a spec there once we get the permit.

On the New Jersey property, how soon could you be out of the ground there?

Well, we’re in the process now of getting the building permit.

I’d say when it thaws.

Yes, probably by the time it thaws. Yes, this Spring. And that’s a market – overall, if you look at the New Jersey market and you go as far as Exit 8A, the vacancy is probably 9 or so percent – 10%, but if you look from Exits 10 to 13 you’re looking at probably under 6% vacancy, so that’s a very robust market.

Our transaction of choice, David, is still do a build-to-suit. But we will do some speculative in those markets.

Okay. And then in terms of the competitive landscape in Ontario, do you know what the status is on leasing, on the building that you sold to CB a couple of quarters ago?

I was just thinking that when you asked your question. I don’t know the answer to that. I assume their doing finance. I’ll see if I can get someone to tell me that in the next minute.

Okay. And then just an update on GAAP. Are you hearing anything new from them, either in terms of either occupying that space or looking for some sort of lease termination there?

We are not at this point talking in those terms. They are obviously still paying rent and there are possibilities perhaps of doing some subleasing. But we have nothing to report.

No update there.

Okay. And just one final question. Could you give an update on any progress on the land you purchased in Aurora earlier in the year?

We haven’t made a move on that yet, although we are going, as Nelson mentioned, it’s kind of our last building in Stapleton. We’re going to start a spec building there. And then the next place we would – when we’re out at Stableton’s the next place we’d look is Aurora.

Okay, great. Thanks, guys.

And your next question comes from Steve Sakwa, from Merrill Lynch. Go ahead, sir.

Good afternoon. Bill, I don’t know if you can – looking at page 30 on the supplemental you’ve broken out this urban residential. I guess I’m just trying to make sure I understand kind of where PAC Commons stands today, just in terms of maybe what’s been completed in terms of land leases or things that have already kind of flown into the income statement and what’s still left in terms of I guess total development out of Pat Commons?

Because we’re right in the middle of it, Steve, it’s going to be hard. It is hard to follow and I apologize for that. We have signed the three ground leases, so they are going to be out of land inventory and into development, I believe. Although I’ll try to get confirmation on that. As of year end though we had nothing else, so everything else should be sitting in land inventory.

Okay. And then I guess at the Santa Fe or down at the San Diego project?

In San Diego as of year end we had two sites left there, one of which actually is closed now here in January. That’s about 4.5m. The other site we expect to close for somewhere around $7.5m to $8m, but probably not for at least a year. And then that’s it.

That would finish up Santa Fe [inaudible].

Okay. I guess maybe I’ll follow-up with you on PAC Commons afterwards.

Okay. Again, I need to come back to you on that.

Okay, thanks.

And your next question comes from Greg Whyte, from Morgan Stanley. Go ahead, sir.

Good afternoon, guys. I wonder if you can give me a feel – I’m trying to think through your growth numbers here in terms of the call guidance. Let’s, for argument’s sake, say it’s around sort of 5% over what you posted in ’03, which is obviously a lot lower than what you had guided a number of years ago. And I realize we’re not necessarily talking apples with apples, because of breaking out core and the balance of the business.

Well, and we pay out $110m now to our shareholders.

Right. And it’s not a criticism, more an observation. But in terms of the redeployment of non-core assets into the core portfolio, I’m just curious to know how much of your guidance includes further deployment there? What I’m trying to do is get to sort of a core growth number and then how much is coming from asset repositioning.

The core growth is really going to be through development here over the next year or two, because I do think same store is going to be under some pressure here, at least in the next year, unless interest rates go up. So it’s going to be a function of developing new industrial buildings. We are, I think as someone else pointed out earlier, we are fairly liquid. Our debt to capital is fairly low. And we would love to find more things to build on the development side.

So in terms of growth from that perspective, it’s going to come from, again, over the next year, from development adding to NOI and that should more than offset any flat to slightly negative same store. The impact then you’re going to see otherwise, Greg, is as we monetize these other assets, we have to do something with the money. What we’ve done with a lot of the assets we monetized last year is we actually took notes back.

And you commented I think in an email this morning on that fact. We structured those deals to take back notes, because the reinvestment on cash/paying down debt is the other alternative right now.

Also Bill, we all know the cap rates are such today that re-deploying that capital into purchasing assets we don't think makes a lot of sense right now. So having income from those secured loans, or debt is a very good interim step as we look for capital markets and opportunities to invest [inaudible].

Yes, so I’d say really, Greg, in these numbers that you’re seeing here for 2004, there is not a lot of contribution from these other core assets, where we’re getting kind of a mid-single digit return on some of these notes that we took back. But otherwise, we’re paying down debt, so that’s anywhere from 3 to 6% type returns in the near-term.

Okay. Then just on the operating expense side – and you did isolate some sort of pieces that were kind of moving or somewhat unusual, but you had your expense margin rise fairly significantly over the last three or four quarters. Is it fair or safe to expect that number to come down a little bit, but maybe not go down to the levels it was in fourth quarter ’02?

I think that’s probably a fair way to summarize it. Yes, there’s a couple of different things going on. As the office vacancy has increased, we’re clearly not collecting any rent on that. That's affecting the ratio between operating costs and rent. We did have fairly high levels of repairs and maintenance in the third and predominantly fourth quarter, just getting things kind of tidied up. And then we did change the way we accounted for these CFD bond interest expense.

We found that some of the projects we were treating as property tax up in the operating cost section, some of it we were treating as interest and we have reclassified that going forward, all as property operating expense. So that’s kind of a one-time step change. It doesn’t affect the bottom line, but it affects kind of the NOI line. But I think your summary is fair, that it should improve a little bit, but it won’t get back to where it was in the fourth quarter of ’02, for that reason.

And just one last question, maybe for Nelson. You announced sort of a management change. I guess Tim’s going to leave in a year’s time. Can you make any comments on that? And also give us some color as to, are you expecting other management changes or senior departures?

Well, first of all, let me just say, Tim was the first person I hired when I came to Catellus and has made enormous contribution to success that we’ve enjoyed. Tim will be staying with us until the end of the first quarter of next year and will be fully engaged with so many of the transition issues, including working with me very closely on the monetization of the non-core assets. We have already had some management changes as part of the transition. That took place during the course – throughout the year. At this point we do not look to any other senior management changes.

Okay. And maybe one last question. Any activity at Mission Bay at all?

There are some transactions. One for example, we closed at the very end of last year, was a sale to Signature Properties of a condominium site. The price was about $102,000 a unit. Our Glassworks project, which is a condominium project with 34 units, we have a few units left that have not been sold, so that was encouraging. The N1 project, we are in the process of getting occupancy permits in phases and stages there. And so that’s looking well. We have a number of transactions we are in the process of negotiating, but nothing to report beyond that.

Thanks a lot, guys.

One comment on David Copp’s CB Rich [indecipherable], I don’t believe that that is leased yet, but I do think they’re very close with somebody right now.

And your next question comes from Gary Boston, from Smith Barney. Please proceed, sir.

Good afternoon. Bill, just a couple of questions on the non-core sales for ’04. I know it’s hard to predict, but should we be looking for sort of a more sale off of some of the projects like we saw with Talega, or is it going to be more just reducing the inventory, do you think, in ’04?

I think if we had this call a year ago and you asked me that question, I’d answer the same way I’m going to answer now, which is we kind of plan one way and hope for another. If that makes any sense to you. It would have been difficult for me to predict the Talega deal this time last year, because it’s a sale out of the actual venture. So, I guess the answer to your question is, we are more than willing and interested in doing that, but it’s a balance of the timing that cash would otherwise come in, versus the price we’d get by selling it to our partners. Does that make sense?

Yes, I think so. It sounds like you’d take a look at it, but there’s nothing brewing particularly.

Yes, I mean we fully expect to transition out of these assets. Ideally we’d like it to happen very soon, but not to the point where we discount them severely.

In terms of the Pat Commons, those two build to suits, Office Depot, I think, and Circuit City, are those expected to be sold once they’re completed?

Well, we haven’t gotten that far in our thinking. I think that they will produce very attractive income. The return on cost is very good, because of our land bases. So we have not made that next decision.

I would say we’d be leaning against selling those, just because they’re fairly good credit long-term leases and as you know, anything we sell we need to exchange into something and we’d have to sit and make that decision.

I mean, I guess from my standpoint, although it’s retail, it doesn’t have, certainly over the next ten years, retail like it’s not going to track the retail market, because essentially they’re net leased for a long period of time. It’s going to track more like a long-term credit lease.

And then just one more point. I made it earlier in response to another question. Given where the cap rates are for assets that would be in our core business in industrial, it is not our intention to be acquiring in this market condition, but rather, growing through the development process. So, anything we were to sell would then put us in a situation of reinvesting the cap rates we are not too interested in acquiring property for.

On that point on the development, you talked a little bit about your appetite for speculative development in certain markets. You started at about, it looks like 4.5m square feet this year. Any sense on the order of magnitude how much we could see in terms of starts for next year?

Three to four, 4.5m, somewhere in there.

So a similar pace.

A similar pace, yes.

All right. I appreciate it, thanks.

And your next question comes from Christopher Haley, from Wachovia Securities. Please proceed, sir.

Hey guys, it’s Greg Karondi with Chris. Just following up on the starts in the development side of it. What level of development do you guys see being delivered in ’04 that was incorporated in the guidance?

I’d have to go through building by building. Essentially, what’s in our under construction right now, I think there’s a schedule provided as to when it completes. Everything but one building is leased, so they’ll start contributing right away. The building that’s not leased that we started just in December, we’re very close to getting leased and that should complete somewhere toward the end of third quarter, early part of the fourth and should contribute. So essentially everything we have in work in process now should contribute this year.

Not for a whole year.

Not for a whole year, but for that remainder. It would be hard to start anything else and have it contribute this year, at this point.

Okay, so no additional from the pipeline?

Not that would contribute. It would take six to nine months to build it and release right away, maybe we’d get a month or two in.

Any comment on leasing costs TIs [INA] and leasing commissions and how they’ve been trending maybe in Q4? I think you guys gave an annual number, but not a quarterly. Have they been trending flat?

I don’t think there’s any particular trend there. And I’m going to speak in terms of industrial. Office, I think the trend is more typical. We did have a lot of building improvements in the fourth quarter – or I’m sorry, in 2003 for the industrial. It’s $7m. It looks a little high to me. We had a building we bought over a year ago that we didn’t build, and we needed to upgrade the sprinkler system in it and we put ConAgra in the building. So that actually accounted for $2m of that cost. And then we had a – if everyone remembers, the saga of Level 3, and a couple of buildings that we had in Freemont, leased to Level 3, we’ve re-leased those to a company called Syntax. And as part of that re-leasing we actually had to spend some money tearing out some of the Level 3 improvements, so that was actually $3m of our $7m building improvements were actually tearing out TIs. So, that number seems a little high. That’s higher than typical, because of those two deals. But on the TIs and leasing commissions for industrial, it’s pretty much the same as it’s always been.

All right. And you mentioned in Q1 there would be a positive impact from JV activity at land sales and the build to suit. Any sort of quantification on that?

I think in the guidance we showed sales gains as $16m for the year. Now remember that this gets offset by G&A and taxes, so when it gets down to the bottom line it’s a much smaller number. But it is, I would say the most of that is happening in the first quarter. So it will probably, if I had to take a guess, I don’t have the numbers sitting in front of me, the first quarter could be $0.04 or $0.05 higher than the others just due to those sales.

Great, thanks.

And your next question comes from David Shulman, from Lehman Brothers. Please proceed, sir.

Yes, hello. Good morning, everybody. First question is this, you’re showing in your guidance $27m in total G&A for ’04. How much in additional G&A will be capitalized in ’04?

I’d say we typically capitalize about 20 to 25% of our G&A.

So even splits though, 25% would be like $6m on the core, something like that?

That sounds about right.

Nelson, on my favorite project in Playa Del Ray, anything new to report? I’m ready to buy a lot there.

We’ve just about completed grating. I think they basically completed the grating, exporting the soil.

Yes, the roads are all – I was out there a few weeks ago. The roads are all cut in, the lots are laid out, some of the main sewers in. When I say roads are in, the dirt is cut. The asphalt’s not down.

But the issue there is that we have two--.

Two lawsuits.

Right. Both of them have ended up being appealed to the Supreme Court. Both of them were successfully handled. We won the [indecipherable] trial court and the appeals court. We briefed one case and waiting for a decision on that. That’s the Coastal Commission case. The other was a challenge under [Sequa] where the challenge was that the Coastal Commission’s Affordable Housing Act applied to us – requirement applied and that will also be heard by the Supreme Court. So until those – well, certainly the first one. The second one I don’t think as any kind of injunctive issue. And none of them have stays, none of the two have stays against them. But I think that until at least one of those is resolved, we would not be in a situation of selling those plots.

Okay. And one question on your guidance is, to get it straight, if you think on leases rolling this year for industrial rents, that the market is around 7% below in place rents right now?

It’s market by market. In Northern California it’s more than that. It’s probably in the low 10 to 15, 10 to 12%. Chicago it’s probably in that kind of 5 to 10%. Other places it’s more flat.

Is Southern California flat or up?

Probably up. We don’t have a whole lot rolling there.

Not a whole lot rolling. So that’s why down [indecipherable].

Nothing is dramatically different. These rents historically don’t change a whole lot. What we’ve seen in some of these markets, Northern California clearly because rents got higher there because of scarcity. Places like Texas where rents have rolled down predominantly just because of interest rates and people can build and lease properties at lower rates than they could four or five years ago.

Okay. So it really is, if you take a look at [indecipherable] numbers are going to look like are going to be a little lower this year than where a lot of folks had them, including us, is that industrial is probably a bit softer than what we thought and office is a lot worse. Does that sound sort of fair?

Yes. I think the office impact isn’t even a penny, so although office is worse, it--.

In magnitude, right. But mostly industrials is the rent rolldowns [indecipherable]?

I’d say if we were all sitting here three years ago, we would have said hey, same store, that grows. And I did say that always grows around 2, 3% a year on average. Well, what happened is ’99, 2000, even in 2001, it was growing 5%. And so now it’s growing at minus 2%.

Okay, thanks a lot, guys.

And your next question comes from Rich Anderson, from Maxcor Financial. Please proceed.

Thank you. With regard to the capital infusion into the core business from the non-core, do you book any costs associated with that capital raising in your core FFO? My point is, you’re generating capital in the non-core business, correct?

Yes.

And you’re using that capital to make investments in your core business.

Correct.

Are you booking any cost associated with that capital raising in the core FFO number?

No.

In other words, it seems like free capital to me.

[Multiple speakers] Rich, I sold Talega, $40 odd million dollars. I got in $10m to $15m in cash in a $30 odd million dollar note. The cash just goes into the company and gets used for whatever corporate purposes, which effectively benefits the core segment, because the non-core segment doesn’t really run with much cash. So that’s a dividend out to the core segment if you think about it that way. The note is also dividend out to the core segment, so it will produce interest this year. You can see the big notes receivable on our balance sheet. [Indecipherable] that will do that.

My question is – my longer-term question is, at some point, once you have less of this sort of capital raising source from the non-core businesses, won’t your sort of – could you envision that your growth prospects will decline in the core FFO, because you’ll now have to go out and raise capital like everybody else?

In theory, but there’s a couple of things. One, fortunately or unfortunately, we’re not actually using any of that capital all that productively right now, because there’s not a lot to invest in. We’re way over funded from a liquidity perspective. So, your point is, should the sale of those non-core assets result in higher growth in FFO over time? The answer is yes, it should. And someday we monetize all that non-core and we won’t have all that capital to grow off of, yes that’s true. That has kind of a longer-term effect than it does over the next year, because it’s unfortunately not contributing that much right now.

Okay, thank you very much.

And your next question comes from Jay Leupp, from RBC Capital. Please proceed.

Hi, I’m here with David Copp, with a follow up. Bill, could you talk a little bit about, given your capital position, what you expect refinancing activity to be? And also maybe cover a little bit what your target coverage ratios are intended to be for interest coverage and fixed charge coverage and also dividend payout on FFO and FAD?

Okay. In terms of debt, because of the – and this question, Jay, is going to be very much of a function of what we monetize in the non-core. That’s the biggest thing swinging us one way or the other. And as Nelson said, we don’t envision certainly a lot of acquisitions this year, so our capital usage will be limited to development and some land acquisition. And that business tends to be almost self-supportive from a capital standpoint.

So, if we were borrowing at kind of a normal rate – well we’re not really borrowing that now, so you’ve seen our debt actually come down year-over-year pretty substantially. And I don’t know that it’s going to come down – I don’t think it’s going to come down as substantially again, because we also started the year with a whole bunch of cash last year, which essentially went into paying debt, net net. This year I expect our debt to be relatively flat. We probably will try to take some of the shorter-term debt and see if we can make it some longer-term debt, but we really don’t have a lot to even play with on that angle.

So in terms of our coverage ratios, that again, needs to be qualified. They move around erratically, based on the sale of the non-core assets. If I push out that – if I forget that business and just look at the core, they should stay pretty much in line where they are. I don’t expect the debt to change a whole lot.

With regard to payout ratio, we initially set our dividend indication a year ago. What we looked at was – and now I’m going to pick up from the conversation I just had with Rich. But we looked at our core segment FFO to AFFO and we set our dividend pretty much near the top of that, so 95% of what I call a core segment AFFO. With the theory being that we’re going to be generating so much cash over the next X years out of this non-core business and our development activity is essentially self-funding. We’re starting with a fairly, kind of clean balance sheet that we feel we could pay that level of dividend.

Now as our core FFO grows and AFFO grow, we may and will likely make that spread a little bit bigger over time. I don’t know that we would – I mean, we’re not going to target five years from now paying out 95% of our core segment AFFO. But in the meantime we view that over the next three, four years, our FFO should grow and our AFFO should grow to more than comfortably support the dividend we’re paying.

With the profits that you’re booking on some of these larger land sales, could you potentially run into an issue that would force you, for tax reasons, to pay a special dividend?

It could. Now follow with me, those sales are happening in a taxable REIT subsidiary and we’re paying taxes. Then we dividend that money up to the REIT and that dividend becomes taxable income to the REIT. On the good side, it’s actually qualified income when we pass it through to the shareholders. So we could in theory, if we had a whole bunch of sales at one point in time and pushed all the money up to the REIT, it could potentially trigger a kind of a special dividend. And we’re trying to take that into account in any sort of guidance or anything we give.

We don’t see that happening this year. Again, unless we were very much surprised on the upside with sales, we don’t think that’s a big factor. Because we’re paying such a high percentage of AFFO on the core segment, we are prying out dividends in excess of our taxable income. So there is some cushion, if you will. So we’d have to have a fairly extraordinary amount of sales to push us over the limit in the near-term. Does that answer your question?

Yes, thank you. And then Nelson, just a follow up more globally on California. Post recall now, less, obviously, news nationwide about the California government situation. But could you give just your assessment of California’s ability to attract new companies and generate job growth over the next couple of years, to attract more tenants to the markets here to grow rents?

Well, let me make just a forward view comment first. You’ve heard me say this before. Things were never as good in California as people thought they were and things are never as bad as people think they are. And so, there’s a misperception that sometimes exists about California.

The second observation I’d make is that the headlines written about California in 2003, I gave a speech not too long ago, on the subject, and I used almost the same headlines. But the fact is, they were taken in 1992. And we recovered from that.

So, the point I guess is that there’s no question that California does have business [climate] issues. There is no question we have worker’s comp problems. There’s not question that the state was in a very, very bad fiscal crisis. But it’s also, no question, it’s a great place to live and people want to locate here. And what’s happened is that we’ve been constantly recycling jobs over my lifetime in California. And when we go through a downturn, which we have, people write the stories that we’re going to lose these jobs.

The fact of the matter is, Southern California is very robust. Orange County is very robust. Inland Empire is very robust. San Diego is very robust, as well as the Sacramento area and the San Joaquin Valley. The Bay area, particularly Silicon Valley, is still reeling. And that’s largely because things that were not sustainable tended to end. And it was too big of a boom.

So I think that we’re going to recover. I think that the problems that led to the recall are being sorted out. I think that there are several initiatives on the ballot in March that may address these if they’re passed. And I think California will continue to do well.

Thank you.

Thank you. And ladies and gentlemen, if you wish to ask a question, please press star followed by one. And your next question comes from Jim Sullivan, from Green Street Advisors. Please proceed.

Thanks. Bill, you talked about the deferred taxes. You have [tax] REIT conversions 56m on the balance sheet. Are those deferred taxes of a nature that you’ll be able to continue to defer them for some period of time or is there a piece of that 56m that may actually result in cash tax payments over the next couple of years?

It breaks into only two pieces. One is an accrual really, or deferred tax accrual relating to built-in gains at the REIT. So for example, I have land leases in some property at the REIT where the tenant has an option to purchase those properties sometime in the next ten years. So if a tenant exercised that option and for some reason I can’t exchange the property, I’ll actually pay a tax at the REIT level. So that’s about half of what that deferred tax is relating to. So what I would call potential built-in gain exposure on purchase option property in the REIT.

Which if you did 1031s you could continue deferring?

Correct. The other half relates to assets in the TRS, predominantly Mission Bay and Union Station land. So when those parcels are sold, we will trigger those taxes.

Again, with the potential for 1031s?

I guess there’s less potential there, because we’re clearly saying the tax REIT subsidiary is basically a land company. So it’s dealing in land. So I think we have less ability to do that. And also, the reward for doing it is minimized, because the income then in TRS would be taxable going forward. So, in theory, I guess it’s possible from your standpoint, whatever value you assess on the assets in there, you should probably affect the tax in such a way, assuming that if we sold them for more than the tax basis, we’d have to pay some tax.

Okay. And then just a conceptual question regarding your entry into New Jersey. Help me understand how you can go to a market like Northern New Jersey, where there is no shortage of well-capitalized industrial developers, many of whom have very strong roots, within that market. How do you go to a market like that, plant your flag, buy a piece of land, build some spec space and achieve success, again, given the competitive environment?

Well, let’s go back and look at what we’ve done. First of all, we moved into other markets beyond our core portfolio, from Chicago, whether it’s Atlanta. And we have an extraordinary [indecipherable] team, headed up by Ted Antenucci. We have a core competency that is very unique and that’s a core competency of begin able to take land that perhaps has some environment issues, like the Kaiser Steel Mill, like the Hercules site, and are able to have a competitive advantage.

The issues that are there are mostly federal kinds of issues, dealing with Brownsfields and the like. And that skill set is transferable anywhere where those various clean air, clean water act and the like standards apply. So I think that it’s a very special core competency which we developed and developed over time, because of the portfolio that we kind of started with here at Catellus. Ted has put together a tremendous team of professionals.

And we’ll see how it comes out. But we are very interested in that market. As we’ve discussed before, major distribution markets in the country, Southern California is the largest. Chicago is the second. Northern New Jersey is the third, Atlanta fourth and Dallas fifth. If we are going to continue to expand our core business, a distribution warehouse, we want to make a stake in Northern New Jersey and time will prove that we’re correct that we can do it. But I really have great confidence in Ted and his team and the skill set that we’ve acquired.

Jim, I’d say that Inland Empire there is no bigger industrial market and there is no market that has a larger number of well-capitalized developers. And the Kaiser site, which sits right smack at ground zero in the Inland Empire has been sitting there for a couple of decades now. And it’s been available for a long time. The way we were able to compete there is through, as Nelson mentioned, some of these more unique skills. And as a result we’re developing building after building there with investment grade credits north of 10% return on cost in today’s market.

So, when I then look at New Jersey and it has no shortage of needs in terms of industrial, similar to Inland Empire, the port is driving a lot of demand there. A lot of the existing space up near the port is very old. There isn’t a lot of state of the art space. And the reason is, there isn’t a lot of green field land for people to develop on. There is a lot of brown field land. So that’s conceptually how we hope to make an impact there.

But I will tell you too, we’ve been talking about it for a year or two now and we have one site that we’re going to start on this year. So our expectation is it gets more than that, but we’re trying to find the right way to do it.

How are you staffing the geographic expansion? Have you set up a regional office in Atlanta? At what point in time might you set up an office in New Jersey?

Well, we are staffing the Atlanta out of Dallas at this point and we are staffing New Jersey out of Chicago. As we get a bigger presence in those markets we will obviously expand in order to do that. What we feel very good about, for example, is our move to Atlanta was with a preexisting tenant relationship and 1m square feet pre-leased to build to suit. And so, as we continue to expand in that market, we would expand our staffing. But we’ve done this now, over the last several years as we’ve expanded, we’ve tried to get a foothold and then like in Denver, for example, as the success continues we would then staff up to meet it.

Okay, thanks a lot.

And your next question is a follow up question from David Shulman, from Lehman Brothers. Please proceed.

Hi. On the impairment charge, where does it appear on the income statement, in what category?

It’s in our cost of sales, David.

In your cost of sales. This was in Q4 or was this earlier in the year, the 6.7m?

Yes.

And it’s just sitting in the cost of sales?

Yes. And to be perfect, we probably would have a separate line item called impairment. We have historically not have a lot of impairment and the idea of having a line item sit there for several years in a row, I just, for $6m we put it into there.

Okay. You could put an asterisk there, that would help.

Yes. It’s in the supplemental.

It’s in the supplemental, but you’ve got to hunt and peck to find it.

In the K it will allover. We’re definitely not trying to--.

Yes, I know that. It was just a stylistic question.

And it did run through the core segment. It had to do with five or six different land parcels done in Texas, the Westminster project in Colorado, Portland, Oregon. The projects were fine, it has to do with absorption timing. [Indecipherable] absorption, you discount it back.

Okay, thank you.

There are no further questions at this time.

Thank you.

Thank you very much for your participation today. And we look forward to the results of the year as we progress and remind you that this is on tape for those who would be interested.

Yes, Rhoda will read back the callback information. Thank you, Rhoda, we’re done.

The replay for this call will be available in one hour’s time and is available for 15-days. The access code for the replay is 90980546. That’s 90980546. Local dial-in number is 617-801-6888. That’s 617-801-6888. And the toll free number is 888-286-8010. That’s 888-286-8010. Thank you for your participation in today’s conference. This concludes the presentation and you may now disconnect. And good day.